Hi, I’m Chris Walton, author of this guide and CEO of Eton Venture Services.
I’ve spent much of my career working as a corporate transactional lawyer at Gunderson Dettmer, becoming an expert in tax law & venture financing. Since starting Eton, I’ve completed thousands of business valuations for companies of all sizes.
Read my full bio here.
As a board member or investment manager managing a transaction, your goals include:
Fairness opinions help with these challenges. They’re an independent review that remove any conflicts of interest and validate the fairness of the transaction.
But, are they always required? When do you need to get a fairness opinion? In this article, we’ll explain when is a fairness opinion required.
We’ll also share five real-life examples where inclusion or lack of fairness opinion made a big (positive) difference in the deal outcomes.
Key Takeaways
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A fairness opinion typically validates whether the price offered in a big financial transaction is fair to the shareholders—which is especially important when there might be conflicts of interest in a deal.
According to investment bank Houlihan Capital, there are 8 key situations where obtaining a fairness opinion is advisable, along with others where it is mandated by Securities and Exchange Commission (SEC) regulations:
The benefit of fairness opinions is both peace of mind and thorough legal due diligence.
At Eton, we’re a boutique team of Stanford Law lawyers and Ex-Big 4 Consultants. We’ve done thousands of M&A advisory arrangements, valuations, and transaction opinions over the last 20 years.
Our fairness opinion reports are fast, affordable and thorough. And we’ll be with you to defend them in court if needed.
Now let’s look at five different case studies where a fairness opinion was needed in various situations – during mergers, corporate restructuring, management buy-outs, and more.
The fiduciary duties of the board of directors include:
Fairness opinions help the board of directors fulfill their fiduciary duties by making sure they make smart decisions based on independent financial analysis.
In the merger of Hewlett-Packard (HP) and Compaq, the decision to merge was based on the belief that combining the two companies would create a stronger, more competitive business.
The goal was to compete better with big industry leaders like Dell and IBM.
Walter B. Hewlett, though a board member and son of one of HP’s founders, was opposed to the merger.
He was worried that merging two large companies would be hard and that it could weaken HP’s successful printing and imaging business by mixing it with Compaq’s less successful personal computer market.
He sued HP, saying that the management had misrepresented facts about the merger and pressured shareholders to approve it.
However, during the final stages of the merger, both companies’ boards of directors had looked at fairness opinions from their financial advisers before approving the deal.
The court found that HP’s management had acted in good faith, provided accurate information regarding the merger’s integration process, and that there was no evidence of coercion or improper influence over shareholders vote in favor of the merger.
The court ruled in favor of HP, and the merger went ahead.
In the landmark case of Smith v. Van Gorkom, the Delaware Supreme Court decided that the TransUnion board of directors acted with gross negligence when they approved a merger between TransUnion and Marmon Group without enough information or advice from independent experts.
TransUnion was having financial problems, due to accelerated depreciation and reduced income, so the board thought about selling the company.
The board was greatly influenced by TransUnion’s CEO, Jerome Van Gorkom, who suggested a merger at $55 per share without consulting outside financial experts.
In a quick 20-minute meeting, Van Gorkom gave a short presentation but didn’t explain how he decided on the $55 price or fully explain the company’s financial issues.
The board approved the merger based on this limited information, trusting Van Gorkom’s belief that the market would show if the price was fair. Gorkom believed the market would confirm the fairness of the sale price by either attracting higher bids if it was too low or showing little interest if it was too high.
The board was told that a fairness opinion wasn’t legally required, so they moved forward without it.
However, the Delaware Supreme Court ruled that the board was grossly negligent because they failed to fully inform themselves of the company’s true value.
The court concluded that the TransUnion board didn’t do their job to protect the shareholders.
So, the board wasn’t protected by the business judgment rule, which usually keeps directors safe from being blamed if decisions are made in good faith.
The merger wasn’t approved, and the board was held responsible for not doing their duty.
Read more about the case here.
Fairness opinions are important in management buyouts—when internal managers buy a company from its current owners or shareholders—because the potential for conflicts of interest is high.
Managers are supposed to work in the best interest of shareholders, but when they want to buy the company, they are working as agents for both the buyers and sellers.
One famous example of an MBO is the case of RJR Nabisco.
RJR Nabisco was formed when R.J. Reynolds, a tobacco company, merged with Nabisco Brands, a food company.
RJR Nabisco’s CEO, F. Ross Johnson, led the buy-out. Johnson believed that the tobacco business, which was facing bad public opinion and losing money, was hurting the more profitable food division.
After the 1987 stock market crash, RJR Nabisco’s stock price fell dramatically, dropping from $70 to just $40.
Despite this huge drop, the MBO led to a bidding war, getting the purchase price offer to go as high as nearly 3 times the stock price.
Although Johnson offered $112 per share, Kohlberg Kravis Roberts & Co.’s (KKR) $109 per share bid was accepted because it had better financing and lower risk.
Despite better financing, the deal left RJR Nabisco with a huge $25 billion debt.
“In the end, the RJR Nabisco LBO mostly benefited a few Wall Street insiders who earned a windfall in advisory fees for themselves while saddling a reasonably healthy company with an unsustainable level of debt,” writes Investopedia.
A fairness opinion might have provided an unbiased view of the offers, possibly preventing the massive debt and ensuring a fairer outcome for shareholders.
A fairness opinion helps make sure any deals during a company’s restructuring–like merging with another company, selling off a part of the business, changing the capital structure such as issuing new debt or equity–are fair and reasonable for everyone involved.
Teck Resources Ltd is a top Canadian company that mines and provides important metals needed for global development and energy change.
The company decided to split into two separate, publicly-listed companies, each focusing on different resources.
This was done to make it easier for each company to focus on its own goals and give investors the choice to invest in either:
To ensure the split was fair, Teck Resources hired the M&A advisory firm Origin Merchant Partners and BMO Capital Markets to provide fairness opinions.
They concluded that the split was financially fair for Teck’s shareholders, validating that the distribution of assets and value between the two new companies was equitable.
Going-private transactions happen when a company that is traded on the stock market becomes privately owned.
This usually happens when a group of investors, sometimes including the company’s managers, buys out all the public shareholders, taking the company off the stock exchange.
This creates conflicts of interest as the company’s managers or big shareholders are involved on both sides of the deal. They also usually know more about the company’s true value than the smaller shareholders.
So fairness opinion helps ensure the deal is fair for everyone.
It’s legally required to get a fairness opinion in going-private transactions under SEC Rule 13E-3.
This rule says that companies must provide a detailed discussion of the fairness of the transaction, including any fairness opinion they have received.
In the going-private transaction of Heron Lake BioEnergy LLC (HLBE) by Guardian Energy Heron Lake LLC, HLBE engaged Business Advisory Services, Inc. (BAS) to provide a fairness opinion.
BAS utilized three methods to value the company:
After a thorough evaluation, BAS concluded that the financial terms of the transaction were fair from a financial perspective to HLBE.
This fairness opinion helped ensure that the transaction was fair and reasonable for everyone involved.
Fairness opinions are not always required by law, but they are mandated in specific situations, such as in:
The fairness opinion mandate refers to situations where obtaining a fairness opinion is required by law or regulation.
Fairness opinion standards are the rules and best practices that guide how fairness opinions should be made and shared.
These standards include:
These standards make sure that the fairness opinion is a trustworthy and unbiased evaluation of the financial fairness of a deal.
Schedule a free consultation meeting to discuss your valuation needs.
Chris co-founded Eton Venture Services in 2010 to provide mission-critical valuations to venture-based companies. He works closely with each client’s leadership team, board of directors, internal / external counsel, and independent auditor to develop detailed financial models and create accurate, audit-proof valuations.
